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Three different ways synchronization can cause contagion in financial markets

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Abstract

We introduce tools from statistical physics, to capture the dynamics of three different pathways, in which the synchronization of human decision making could lead to turbulent periods and contagion phenomena in financial markets. The first pathway is caused when stock market indices, seen as a set of coupled integrate-and-fire oscillators, synchronize in frequency. The integrate-and-fire dynamics happens due to "change blindness", a trait in human decision making where people have the tendency to ignore small changes, but take action when a large change happens. The second pathway happens due to feedback mechanisms between market performance, and the use certain (decoupled) trading strategies. The third pathway can take place because of communication and its impact on human decision making. A model is introduced where financial market performance has an impact on decision making through communication between people. On the other hand the sentiment created via communication has an impact on the financial market performance

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  • Naji Massad & Jørgen Vitting Andersen, 2017. "Three different ways synchronization can cause contagion in financial markets," Documents de travail du Centre d'Economie de la Sorbonne 17059, Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne.
    • Handle: RePEc:mse:cesdoc:17059
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    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G4 - Financial Economics - - Behavioral Finance

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